Research

John Cochrane 5/21/15 John Cochrane 5/21/15

Comments on "How Can Central Banks Deliver Credible Commitment and be 'Emergency Institutions'"

By Paul Tucker. In John H. Cochrane and John B. Taylor, Eds., Central Bank Governance and Oversight Reform, Hoover Institution Press May 2016, p. 31-36. (Chapter pdfs available here) Comments presented at the Hoover conference by the same name, May 21, 2015. Tucker's paper here. Tucker wisely advocates rules for mop ups, lender of last resort, bailouts, etc. I agree, but wouldn't lots more equity so you don't have to mop up be simpler?

John Cochrane 4/11/15 John Cochrane 4/11/15

Comments on "Neoclassical Models of Aggregate Economies"

Comments on Gary Hansen and Lee Ohanian, "Neoclassical Models of Aggregate Economies" at the Conference on the Handbook of Macroeconomics, Volume 2, Hoover Institution, April 11 2015.

Comments on Gary Hansen and Lee Ohanian, "Neoclassical Models of Aggregate Economies" at the Conference on the Handbook of Macroeconomics, Volume 2, Hoover Institution, April 11 2015.

John Cochrane 1/19/15 John Cochrane 1/19/15

Continuous time

Note covering dz, dt, stochastic integrals, and how to do all of Asset Pricing Chapter 1 in continuous time.

Note covering dz, dt, stochastic integrals, and how to do all of Asset Pricing Chapter 1 in continuous time.

John Cochrane 1/9/15 John Cochrane 1/9/15

A Response to Sims (2013)

January 2015. Chris Sims' (2013) "Paper Money" seems to include a criticism of my "Determinacy and Identification with Taylor Rules." In fact, there is no fundamental disagreement between the two papers.

John Cochrane 11/4/14 John Cochrane 11/4/14

Toward a run-free financial system

November 4 2014. In Martin Neil Baily, John B. Taylor, eds., Across the Great Divide: New Perspectives on the Financial Crisis, Hoover Press. This is an essay about what I think we should do in place of current financial regulation. We had a run, so get rid of run-prone liabilities. Technology and financial innovation means we can overcome the standard objections to "narrow banking." Some fun ideas include a tax on debt rather than capital ratios, the Fed and Treasury should issue reserves to everyone and take over short-term debt markets just as they took over the banknote market in the 19th century, and downstream fallible vechicles can tranche up bank equity.

John Cochrane 11/1/14 John Cochrane 11/1/14

Challenges for Cost-Benefit Analysis of Financial Regulation.

Journal of Legal Studies 43 S63-S105 (November 2014). Is cost benefit analysis a good idea for financial regulation? I survey the nature of costs and benefits of financial regulation and conclude that the legal process of current health, safety and environmental regulation can't be simply extended to financial regulation. I opine about how a successful cost-benefit process might work. My costs and benefits expanded to a rather critical survey of current financial regulation. It's based on a presentation I gave at a conference on this topic at the University of Chicago law school Fall 2013, with many interesting papers. JSTOR link with HTML and nicer pdf. The JLS issue with all conference papers.

John Cochrane 10/21/14 John Cochrane 10/21/14

Monetary Policy with Interest on Reserves

Journal of Economic Dynamics & Control 49 (2014), 74-108. ( ScienceDirect link to published version, html and pdf) I analyze monetary policy with interest on reserves and a large balance sheet. I argue for the desirability of this regime on financial stability grounds. I show that conventional theories do not determine inflation in this regime, so I base the analysis on the fiscal theory of the price level. I find that monetary policy -- buying and selling government debt with no effect on surpluses -- can peg the nominal rate, and determine expected inflation. With sticky prices, monetary policy can also affect real interest rates and output, though not with the usual signs in this model. Figures 2 and 3 are the best part -- the effects of monetary policy with and without fiscal coordination. I address theoretical controversies, and how the fiscal backing of monetary policy was important for the 1980s disinflation. A concluding section reviews the role of central banks. Matlab program.

John Cochrane 7/1/14 John Cochrane 7/1/14

Comments on "Mortgage Risk and the Yield Curve"

Comments on Aytek Malkhozov, Philippe Mueller, Andrea Vedolin, and Gyuri Venter, "Mortgage Risk and the Yield Curve," slides presented at the NBER AP meeting, July 2014.

Comments on Aytek Malkhozov, Philippe Mueller, Andrea Vedolin, and Gyuri Venter, "Mortgage Risk and the Yield Curve," slides presented at the NBER AP meeting, July 2014.

John Cochrane 7/1/14 John Cochrane 7/1/14

Comments on "A Model of Secular Stagnation"

Comments on Gauti Eggertsson and Neil Mehrotra, "A Model of Secular Stagnation," slides presented at the NBER EFG meeting, July 2014.

Comments on Gauti Eggertsson and Neil Mehrotra, "A Model of Secular Stagnation," slides presented at the NBER EFG meeting, July 2014.

John Cochrane 2/1/14 John Cochrane 2/1/14

A mean-variance benchmark for intertemporal portfolio theory

Journal of Finance, 69: 1–49. doi: 10.1111/jofi.12099 (February 2014) (link to JF) (Manuscript) Applies good old fashioned mean-variance portfolio analysis to the entire stream of dividends rather than to one-period returns. Long-Run Mean-Variance Analysis in a Diffusion Environment is a set of notes, detailing all the trouble you get in to if you try to apply long-run ideas to the standard iid lognormal environment, and also discusses shifting bliss points a bit.

John Cochrane 5/1/13 John Cochrane 5/1/13

Finance: Function Matters, not Size

May 2013 Journal of Economic Perspectives 27, 29–50 JEP link (Previous title "Is Finance Too big?" December 2012.) Is finance "too big?" Is this the right question? .

May 2013 Journal of Economic Perspectives 27, 29–50 JEP link (Previous title "Is Finance Too big?" December 2012.) Is finance "too big?" Is this the right question? .

John Cochrane 11/12/12 John Cochrane 11/12/12

Having your cake and eating it too: The maturity structure of US debt

November 12 2012 How the US Treasury can both lengthen and shorten its debt at the same time, to buy insurance against interest rate rises and provide "liquidity." A short paper diguised as comments on Greenwood, Hanson, and Stein “A Comparative Advantage Approach to Government Debt Maturity” at the Second Annual Roundtable on Treasury Markets and Debt Management , US Treasury, Nov. 15 2012

Financial Markets and the Real Economy

In Rajnish Mehra, Ed. Handbook of the Equity Premium Elsevier 2007, 237-325. Everything you wanted to know, about the equity premium, consumption-based models, investment-based models, general equilibrium in asset pricing, labor income and idiosyncratic risk. Click the title for more information.

Read the Paper >

In Rajnish Mehra, Ed. Handbook of the Equity Premium Elsevier 2007, 237-325. Everything you wanted to know, but didn’t have time to read, about equity premium, consumption-based models, investment-based models, general equilibrium in asset pricing, labor income and idiosyncratic risk.

This article appeared four times, getting better each time. (Why waste a good article by only publishing it once?) The link above is the last and the best. The previous versions were NBER Working paper 11193, Financial Markets and the Real Economy Volume 18 of the International Library of Critical Writings in Financial Economics, John H. Cochrane Ed., London: Edward Elgar. March 2006, and in Foundations and Trends in Finance 1, 1-101, 2005.

John Cochrane 4/13/12 John Cochrane 4/13/12

Comments on "Volatility, the Macroeconomy and Asset Prices

Comments on "Volatility, the Macroeconomy and Asset Prices, by Ravi Bansal, Dana Kiku, Ivan Shaliastovich, and Amir Yaron, and “An Intertemporal CAPM with Stochastic Volatility” by John Y. Campbell, Stefano Giglio, Christopher Polk, and Robert Turley. Also slides. April 13 2012 Comments presented at the spring NBER asset pricing meeting. I took the opportunity to offer a sceptical apparisal of long-run risks, and whether stochastic volatilty really works as a state variable, especially in the long run.

Juliann Klein 1/28/12 Juliann Klein 1/28/12

A Brief Parable of Overdifferencing

This is a short note, showing how money demand estimation works very well in levels or long (4 year) differences, but not when you first-difference the data. It shows why we often want to run OLS with corrected standard errors rather than GLS or ML, and it cautions against the massive differencing, fixed effects and controls used in micro data. It's from a PhD class, but I thought the reminder worth a little standalone note.

John Cochrane 11/19/11 John Cochrane 11/19/11

The Fiscal Theory of the Price Level and its Implications for Current Policy in the United States and Europe

The Fiscal Theory of the Price Level and its Implications for Current Policy in the United States and Europe November 19, 2011 This is the text of my presentation at the concluding panel of the conference, â€œFiscal Policy under Fiscal Imbalance,â€ hosted by the Becker-Friedman Institute and Federal Reserve Bank of Chicago.

John Cochrane 11/1/11 John Cochrane 11/1/11

Continuous-time linear models

Foundations and Trends in Finance 6 (2011), 165-219. How to do ARMA models, opreator tricks, and Hansen-Sargent prediction formulas in continuous time.

Inflation and Debt

National Affairs 9 (Fall 2011). html An essay summarizing the threat of inflation from large debt and deficits. The danger is best described as a "run on the dollar." Future deficits can lead to inflation today, which the Fed cannot control. I also talk about the conventional Keynesian (Fed) and monetarist views of inflation, and why they are not equipped to deal with the threat of deficits. This essay complements the academic (equations) "Understanding Policy" article (see below) and the Why the 2025 budget matters today WSJ oped (on oped page).

John Cochrane 8/1/11 John Cochrane 8/1/11

Discount Rates

Joural of Finance 66, 1047-1108 (August 2011). My American Finance Association Presidential speech. The video (including gracious roast by Raghu Rajan) The slides. Data and programs (zip file) Price should equal expected discounted payoffs. Efficiency is about the expected part. The unifying theme of today's finance research is the discounted part -- characterizing and understanding discount-rate variation. The paper surveys facts, theories, and applications, mostly pointing to challenges for future research.

John Cochrane 6/2/11 John Cochrane 6/2/11

Is QE2 a Savior, Inflator, or a Dud?

The Federal Reserve’s experiment with a second round of quantitative easing is nearing an end. Did it achieve its goal of lowering interest rates and stimulating the economy?

The Federal Reserve’s experiment with a second round of quantitative easing is nearing an end. Did it achieve its goal of lowering interest rates and stimulating the economy?

Should we remember QE2 as a brilliant innovation, a central piece of the Fed’s future recession and deflation-fighting toolkit? Or is it the first step toward hyperinflation? When the Fed stops buying government bonds, will interest rates rise sharply because no one else is buying?

In fact, QE2 didn't stimulate the economy, as the left had hoped, nor will it lead to the inflationary or bond-market disaster feared by the right. QE2 did basically nothing. But that is a deep and unsettling lesson: The Fed is essentially helpless in the current situation.

The chart attached to the left shows how interest rates behaved through the QE2 episode.

The red dashed line represents total Fed holdings of Treasury notes and bills. You can see the sharp rise starting in November 2010. The Fed purchased $600 billion of long-term government bonds, giving banks $600 billion more reserves in return. (Bank reserves are accounts banks hold at the Fed.)

The vertical lines mark the two big Fed announcements. On Aug. 10, the central bank announced that it would reinvest maturing assets in Treasuries. On Nov. 3, it announced the actual QE2 program.

QE2 doesn't seem to have lowered any interest rates. Yes, five-year rates trended down between announcements, though no faster than before. The November QE2 announcement and subsequent purchases coincided with a sharp Treasury rate rise. The five-year yields where the Fed bought most heavily didn't decline relative to the other rates, as the Fed’s “segmented markets” theory predicts. The corporate and mortgage rates that matter for the rest of the economy rose throughout the episode.

How should we interpret this apparently abject failure? In March testimony before the Senate Banking Committee, Fed Chairman Ben Bernanke saw it as evidence of the central bank's great power:

“Yields on 5- to 10-year nominal Treasury securities initially declined markedly as markets priced in prospective Fed purchases; these yields subsequently rose, however, as investors became more optimistic about economic growth and as traders scaled back their expectations of future securities purchases.”

If yields go down, the Fed is successfully stimulating the economy with QE2. And if yields go up? Well, the Fed is successfully stimulating the economy with QE2. And Bernanke claimed almost miraculous additional effects:

“Equity prices have risen significantly, volatility in the equity market has fallen, corporate bond spreads have narrowed, and inflation compensation ...has risen to historically more normal levels.”

On the other hand, Philadelphia Fed President Charles Plosser warns that QE2 provides too much stimulus: The bank has "a trillion-plus excess reserves," he said, providing "the fuel for inflation."

Expected inflation could explain the sharp rise in long-term yields starting in November. But the rate for 10-year Treasury Inflation Protected Securities, or TIPS, rose in parallel, contradicting that interpretation. Simultaneously denying Bernanke, however, the five-year TIP rate didn't rise. An increase in that rate would have been a sign of a stronger economy in the next five years. The bond market is a tough critic.

Both sides ignore an inescapable conclusion: With near-zero short-term interest rates, and bank reserves paying interest, money is exactly the same thing as short-term government debt. A bank doesn't care whether it owns reserves or three-month Treasury bills that currently pay less than 0.1 percent.

This is what drove the Fed to QE2 in the first place. Conventional easing -- buying short-term Treasuries in exchange for reserves -– obviously has no effect now. Taking away your green M&Ms and giving you red M&Ms instead won't help your diet.

But if exchanging money for short-term debt has no effect, it follows inescapably that giving banks more money is exactly the same as giving them short-term debt. All QE2 does is to slightly restructure the maturity of U.S. government debt in private hands.

Now, of all the stories we've heard to explain our sluggish recovery, how plausible is this one: “Our big problem is the maturity structure of Treasury debt. If only those goofballs at Treasury had issued $600 billion more three-month bills instead of all these five-year notes, unemployment wouldn’t be so high. It’s a good thing the Fed can undo this tragic mistake.” That makes no sense.

For the same reason, when money is the same thing as debt, it doesn’t cause inflation.

Ineffective QE2 doesn't mean harmless QE2, however.

We are in danger of inflation for fiscal, not monetary reasons. If investors lose faith the U.S. will fix its long-run budget problems, they will try to sell government debt of all maturities. Rates will rise and stagflation will break out no matter what the Fed does.

Short-term debt dramatically increases this danger. If the U.S. were financed with long-term debt, bond prices would fall, but there would be time to fix the deficit and restore confidence in the debt. But the average Treasury maturity is less than a year. Every two years, the U.S. must find new borrowers to pay off most of our debt. If those investors depart, a stagflationary crisis must result. Our moment of low long-term rates is a golden opportunity to issue long-term debt, not to buy it back. QE2 was a small step in the wrong direction.

Moreover, QE2 distracts us from the real microeconomic, tax, and regulatory barriers to growth. Unemployment isn't high because the maturity structure of U.S. government debt is a bit too long, nor from any lack of “liquidity” in a banking system with $1.5 trillion extra reserves.

Mostly, it is dangerous for the Fed to claim immense power, and for us to trust that power, when it is basically helpless. If Bernanke had admitted to Congress, “there’s nothing the Fed can do. You’d better clean this mess up fast,” he might have had a much more salutary effect.

(John H. Cochrane is a professor of finance at the University of Chicago Booth School of Business and a contributor to Business Class. The opinions expressed are his own.)

(Link to this article on Bloomberg)

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